The Risky Business Of Margin Trading

In the business world, raising funds is the number one priority to not only survive but also exist. A company that fails to accumulate a launch capital struggles to enter the market. That’s precisely why the initial coin offering process has become a key player of business development, professional fundraising and innovative funding for startups and business diversification. The idea to presale tokens of a project that may not yet exist at the time of purchase is appealing and reminds of margin loans and trading. Indeed, in the case of margin lending, the borrowers can capitalize on an asset that they don’t ‘fully’ own. As the margin is accessible to corporates, limited liability partnerships, limited partnerships and other private and public companies, it’s easy to see how such an investment can also be repurposed in a fundraising strategy. However, new companies with reduced cash flows need to be cautious about the high-risk aspect of margin trading. What seems like an easy and cost-effective gain can also become a crippling loss.

Margin trading, what for?

At the core of it, margin trading enables a borrowing company – or individual – to buy more stock that they would be able to normally. From an investment perspective, it’s about maximizing your gains without blowing up your budget as you can borrow money from a broker to purchase stock. To do this, you’ll need to open a margin account with your broker, in which an initial investment is required – think of it as a deposit for the minimum margin. As a rule of the thumb, the minimum margin tends to be at least $2,000, but the amount varies depending on brokers. Ultimately, this deposit acts as the portion of the purchase price of your stock, aka the initial margin whose proportion can vary with brokerages. The idea is that by paying in only 10%, 25% or even 50% – some brokerages demand that you margin all the way up to 50% and above –, you can receive the benefits of 100% stocks. In conclusion, it’s the ideal starting point for small companies looking to grow their cash flow through investment strategies.

Buying stock on margin

Concretely, when you choose to buy on margin, you can be faced with a variety of trading scenarios that are defined by the type of margin account you are using. If the company uses a concentrated account, it means that the account is formed with one position equal to or greater than 50% of the marginable market value. In this scenario, the margin call from the broker can happen with the slight price drop. With a high maintenance margin requirement, the buyer is greatly affected by all market fluctuations, positive or negative. In a non-concentrated margin account, aka with a smaller margin requirement, the buyer enjoys higher buying power for the same amount of cash. However, fluctuations will have a reduced effect on gains and losses. Nevertheless, if the value of the purchased stock drops, the borrower is affected by 100% of all losses, regardless of the type of account.

Margin trading on prices only

Margin trading can also be applied to CFDs, aka contracts for difference as explained by CMC Markets and which refer to speculation on the rising or falling prices of shares, indices, commodities, treasuries and currencies. In this scenario, the company doesn’t need to invest in physical stock but can choose to go short or long with units of financial instruments. Here too a deposit is required, as it is the regulation with margin accounts. As trading margins can be an extremely volatile market, it’s not uncommon for unlucky newcomers to face losses greater than their deposits or initial margin. Trading on markets with a competitive spread – it is the difference between the buy and sell price – maximize your chances to make a profit. But even a competitive spread doesn’t protect you from fluctuations in prices.

Crypto leverage and margin

Once a borrowing company feels more confident about margin trading, the most rewarding situation is to using margin trades to leverage your cryptocurrency assets. It is essential to know that while margin trading is highly risky, crypto margin trading escalates risks of loss. But it’s a volatile market that requires long-term vision. Without the adequate knowledge, crypto price drop can you to change strategy. Experts are convinced that cryptocurrency will replace fiat, and consequently are more likely to stick with the market despite the current price drops. If their convictions turn out to be true, the gains to come will outdo the losses. However, for less experienced investors, crypto leverage has lost its appeal.

Long-term vision, fluctuating cash flows, and risk of high losses, margin trading on stocks, prices and cryptocurrency comes with many challenges. The chances of high profits are only for the most experienced traders, while less confident borrowers could go bankrupt rapidly.

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The Risky Business Of Margin Trading

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